In the United States, more than 10 million people annually choose to take out online payday loans or from storefronts. For many, access to a payday loan can mean the difference between keeping the utilities on, feeding their families or repairing the car they need to go to work. However, payday lenders have been facing mounting criticism from government agencies and consumer organizations. The Consumer Financial Protection Bureau has announced its proposed regulations for the payday loan industry, and many believe that these new rules could mean the end of online payday borrowing options. The new regulations and increasing criticism leveled at payday loans is due in large part to the belief held by critics that online payday loans do more harm than good.
Rationale Behind Critics’ Claims That Online Payday Loans Online Do More Harm Than Good
Critics charge that the fees related to online payday loans are usurious, often amounting to an annual percentage rate of more than 400 percent. It is true that a $300 payday loan will cost the borrower more than the same amount taken as a cash advance on a credit card. Borrowing from a friend or relative could be even less financially expensive. However, not everyone facing a financial emergency has access to those sources. Furthermore, annualizing the percentage rate is misleading as payday loans are supposed to be repaid in 14 to 30 days.
Critics also claim that online payday loans lead to a cycle of debt that borrowers may have trouble escaping. The Pew Charitable Trusts reports that the average borrower owes money on a payday loan for five months of the year, paying average fees of $520 by repeatedly borrowing $375. The average loan requires a repayment of $430 on the borrower’s next payday, which is the equivalent of 36 percent of the average borrower’s gross earnings for the pay period. This results in many borrowers renewing their loans, paying only the fees to buy more time to repay the principal.
Author, radio host and financial advisor Dave Ramsey calls payday loans “one of the worst financial decisions” an individual can make. He refers to online payday loans as a game that borrowers can never win and claims that they prevent borrowers from finding long-term financial security. Ramsey objects to the annualized rate of interest and recommends that financially strapped individuals find a second job or slash expenses to make ends meet. Although his advice is likely well-intentioned, like many critics, Ramsey misses the point that for many, payday loans online or off are the only viable solution.
The Illinois Attorney General warns that people who are struggling financially may make their situation worse by taking out an online payday loan. The short term of the loan increases the likelihood that the borrower will need to renew the loan on its due date, racking up additional fees. The recommendation is to exhaust all other options, including friends, church and family, before taking out a loan. If a loan is necessary, the advice offered is to seek an installment loan.
The Reality of Online Payday Loans
It is true that some borrowers have become mired in a cycle of debt by taking out payday loans. In many instances, however, the borrower made mistakes or failed to make a repayment plan.
• The Detroit Free Press reported on a man who cashed his paycheck and pocketed the money rather than make a bank deposit. He lost the money, so to pay his bills, he took out a payday loan for $700. When he was unable to repay the loan on time, he took out another payday loan. The cycle of paying fees to renew loans led him to default on the loans, but he lost a legal judgment. The entire process ultimately cost him more than $7,000.
• The Southern Poverty Law Center reported the case of a man who took out a $300 loan. For two years, the man paid $52.50 to renew the loan every two weeks, paying $2,730 in fees and interest without paying a penny on the principal.
• Reports of borrowers having multiple payday loans open at the same time are also abundant. One woman started with a single payday loan, took out a second to renew the first loan and then took out a third payday loan to renew the first two. She ultimately ended up with eight open payday loans on which she was paying almost $400 a month to renew. After receiving financial counseling, she managed to pay off all of her loans, but it took her more than five years to become free from debt.
In other words, online payday loans can be detrimental to the financial health of borrowers unless they plan carefully. However, any form of credit can lead to the same type of financial damage. There are many people with multiple credit cards who are often so financially strapped that they take a cash advance on one card to make a payment on another card. One couple paid off all their debts to purchase a new home, but within two years, they were forced to sell the house to avoid foreclosure due to the cost of making payments on the furnishings, upgrades and landscaping they purchased on credit. They ultimately declared bankruptcy — and they had never taken out a payday loan.
Why Payday Loans Can Be Good for Many Borrowers
Many of the critics have failed to survey the people who actually use payday loans. In March 2016, the results of a survey were published on PRNewswire addressed this oversight. The survey found that payday loan borrowers were overwhelmingly positive about their experience. More than 90 percent considered payday loans a sensible option, and 75 percent said they would recommend them to family members and friends. Approximately 96 percent stated that they fully understood the costs involved. Almost two-thirds were concerned that new regulations will limit their access to online payday loans, and 80 percent stated that requirements already in place to secure a payday loan are sufficient.
Eliminating payday loans by regulating lenders so severely that they can no longer afford to make these loans can cause significant harm. Because many borrowers do not have credit histories that would enable them to secure approval from a bank or credit card issuer, these people will be denied access to credit. Without access to credit, they will be left vulnerable when faced with a financial emergency.
No one should borrow money from any source without first considering how to repay it and ensuring that the reason for securing the loan is sound. For many, a payday loan can be a wise decision. If you would like to learn more regarding the advantages and disadvantages of online payday loans, visit the Personal Money Store.